This was a busy week for economic data and I think it is worth mentioning that while the Core CPI shows a month/over/month increase of +0.3%, the year/over/year increase is now +2.4%; the highest since July 2018. While the Fed watches a different inflation gauge, Core PCE, which doesn’t come out until 9/27, increasing inflation will likely put pressure on the Fed to hold interest rates steady in the coming months.

I’d also like to highlight the Initial (weekly) jobless claims again. Not only was the number better than expected, but at 213k, the 4-week moving average fell to its lowest level since 8/3/19; still indicating no weakness in the labor market.

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Market Performance

Here is the 2019 YTD performance of the market broken down by the 11 market sectors (as of the close on 9/12/19):

Info Tech +31.5%

Real Estate +25.3%

Consumer Disc +24.2%

Communications Svc +24.2%

Industrials +22.3%

Cons Staples +20.2%

Utilities +18.7%

Financials +18.2%

Materials +15.3%

Healthcare +5.5%

Energy +4.8%

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Here is the 2019 YTD performance of the major U.S. equity indices (as of the close on 9/12/19):

S&P 500 (SPX) +20.0%

Nasdaq Composite (COMPX) +23.5%

Dow Industrials (DJI) +16.5%

Russell 2000 (RUT) +16.8%

Technicals

After consolidating early in the week in an uncharacteristically low period of volatility, the SPX rallied in the second half of the week on renewed optimism about trade (see Global Review/Outlook section below) coming within 5 points of hitting a new record high on Thursday (9/12), before giving back about 10 points in the last hour of trading.

After breaking through the 50-day Simple Moving Average (SMA) (currently 2,949) and the 2,954 resistance level back on Thursday (9/5) the SPX has run into almost no resistance on its march back toward all-time highs. I find it quite surprising that market participants have become so optimistic again, despite only moderately improving economic data and still very little prospect of a new trade deal with China; even the USMCA (NAFTA replacement) hasn’t yet been passed. Nevertheless, at the close on Thursday (9/12) the SPX was only 16 points (0.56%) below its all-time high. In the near-term, the previous high of 3,025 remains the only upside resistance level, while 2,954 remains as the first downside support. Whether justified or not, given how close it has gotten already, a new high in the SPX looks almost inevitable at this point.

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Year-over-year comparison

“History doesn’t always repeat itself, but it often rhymes” - Mark Twain. While past performance is no guarantee of future results and with a correlation of only 0.11, clearly the paths of the two charts aren’t that similar over the first 8 months of the year. However, it does concern me that the highest point last year occurred on 9/20/18, and we are approaching an interest rate cut on 9/18/19. Sometimes expected events result in a "buy the rumor; sell the news" downturn. Additionally, while optimism seems to be growing again, over the past year the trade war has actually escalated; not improved.

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

September is the worst month of the year:

Another reason for the comparison above is that historically speaking, September has a rather poor track record for market performance relative to the other 11 months of the year; October is second worst. Here are some facts:

Sept has been an up month only 46% of the time over the past 70 years

The average return for the month of September over the past 70 years has been -0.4%

Performance in recent years however has been better; September has been an up month in 10 of the last 15 years

The average return over the last 15 years has been +0.5%

Option Volumes:

It’s still early in the month, but September volumes are rather modest. After 2 weeks, aggregate option industry volume is averaging 20.7M contracts per day. That is just below the August level of 21.7M contracts per day but slightly above the September 2018 level of 19.2M contracts per day.

Open Interest:

OI Change:

In reviewing CBOE open interest (OI) data (where greater than 90% of the index activity occurs), I observed the following changes over the past week:

In reviewing VIX data for the past week I observed the following:

VIX call OI was +8.1%

VIX put OI was +4.4%

These changes show a small bias to the call side, so I see them as moderately bearish for equities.

In reviewing SPX data for the past week I observed the following:

SPX call OI was +4.8%

SPX put OI was +4.2%

These changes show virtually no bias to the call or put side, so I see them as neutral for equities.

In reviewing SPY data for the past week I observed the following:

SPY call OI was +6.9%

SPY put OI was +5.3%

These changes show a small bias to the call side, so I see them as moderately bullish for equities.

In reviewing QQQ data for the past week I observed the following:

QQQ call OI was +4.5%

QQQ put OI was +7.6%

These changes show a small bias to the put side, so I see them as moderately bearish for equities.

It’s a close call, but combining VIX, SPX, SPY & QQQ data this week, I see the Index OI Change overall as moderately bearish in the near-term. The Equity OI Change shows very little bias to the call or put side this week, so I see it as neutral in the near-term.

OI Participation:

Index OI Participation is currently +16.2% versus 2018 levels, so I see it as bullish in the long-term.

Equity OI Participation is currently -0.4% versus 2018 levels, so I see it as neutral in the long-term.

Open Interest Put/Call Ratios (OIPCR):

The VIX OIPCR is down 1 tick at 0.35 versus 0.36 last week. At this time, VIX options traders are holding (long or short) 35 puts for every 100 calls. At this level, this ratio remains above the 200-day SMA (simple moving average) of 0.31, and it is now 2 ticks below its YTD high. Since this ratio usually moves up and down with the VIX index, this small drop is not surprising given that the VIX is -0.78 points (-5.2%) this week through the close on Thursday (9/12). This reading implies that as the VIX has fallen sharply in the past 4 weeks, VIX option traders have remained relatively optimistic that it will fall even further in the near-term. Therefore, I see the VIX OIPCR as moderately bullish in the very near-term for the markets. Since this ratio has been generally rising over the past month, I see it as still moderately bullish in the long-term.

This week the SPX OIPCR is up 3 ticks to 2.11 versus 2.08 last week. At this level this ratio remains well above the 200-day SMA (Simple Moving Average) of 1.82. It is now 2 ticks below its YTD high. Most of the time, this ratio tends to move in the same direction as the index. Since the SPX has risen more than 30 points (+1.0%) this week, this move is not too surprising and it probably implies that SPX option traders (who are almost entirely institutional) are adding to their hedges along with the SPX gains, in preparation for a potential downside move. Given the SPX is now less than 1% below its all-time high, at this level I see the SPX OIPCR as moderately bearish in the near-term for the market. Given that this ratio has been relatively flat for the past 6 weeks, it is now neutral in the long-term.

The normally stable Equity OIPCR is down 1 tick at 1.04 this week versus 1.05 last week. Even though equities are less than 1% below record highs, this ratio is just below its YTD high. This ratio includes a large retail component and it tends to be a contrarian indicator, so it is not unusual to see it move opposite the SPX ratio. However, at this level I see the Equity OIPCR as still moderately bearish in the near-term for the market. I see it as still neutral in the long-term.

CBOE Volume Put/Call Ratios (VPCR):

The CBOE VIX VPCR has been in moderately bearish territory all week. The 0.37 reading on Thursday (9/12) was moderately bearish and the current reading of 0.14 as I’m writing this (mid-day Friday 9/13) is bearish. Therefore I see it as moderately bearish in the very near-term.

The CBOESPX VPCR has been mostly moderately bearish all week. The 1.70 reading on Thursday (9/12) was moderately bearish, but the current reading of 2.30 as I’m writing this (mid-day Friday 9/13) is bearish. Since intraday levels tend to decline as the day goes on, I see this ratio as moderately bearish in the very near-term. With a 5-day average of 1.88 versus 2.12 last week, it is moderately bearish in the long-term.

The CBOEEquity VPCR has been mostly moderately bullish this week. The 0.55 reading on Thursday (9/12) was moderately bullish but the current reading of 0.81 as I’m writing this (mid-day Friday 9/13) is moderately bearish. While intraday levels tend to fall throughout the day, this one is unlikely to fall enough, so I see it as neutral in the very near-term. With a 5-day moving average of 0.58 versus 0.64 last week, it is moderately bullish in the long-term.

Since volume based put/call ratios are very reactive and very short-term in nature, near-term usually means just a day or two, while long-term is more like a week.

ISE Retail Sentiment Index (ISEE):

The ISEE has closed below 100 in 3 out of 4 days this week. Since this gauge measures only retail opening activity and it is actually a call/put indicator, a level below 100 means that retail option traders on the ISE are trading more puts than calls. Since the intraday level at the time of this writing is 121, I see the ISEE as neutral in the near-term. Since this ratio has now closed (mostly modestly) below 100 in 35 of the last 36 sessions, I see the ISEE as moderately bearish in the long-term.

OCC Volume Put/Call Ratios (VPCR):

The OCC Index VPCR has been moderately bearish this week, so I see it as moderately bearish in the near-term. Also, it has been bearish or moderately bearish in 14 of the last 14 sessions, so I see it as moderately bearish in the long-term.

The OCC Equity VPCR has been neutral or moderately bullish this week, so I see it as neutral in the near-term. It has only recently switched from moderately bearish to neutral, so I see it as neutral in the long-term too.

Volatility:

As I mentioned in the OIPCR section above, the VIX is -0.78 points (-5.2%) this week through the close on Thursday. Additionally, the VIX has fallen more than 10 points (-44%) over the last 5 weeks. As a result, the 20-day historical volatility has continued to fall as well; dropping to 123% this week versus 179% last week.

Cboe Volatility Index (VIX)

As the VIX continues to fall, it is now back to within just 2 points of its YTD low. I find this very surprising as very few (if any) of the issues that have caused volatility over the past 2 months have been resolved. As I’m writing this (mid-day Friday 9/13), the VIX is -0.39 points (to 13.80). This is barely above its long-term statistical mode of 12.42 (which I consider “normal” volatility) but well below the long-term statistical mean of 19.20. At this level, I see the VIX as moderately bullish in the very near-term for the equity markets. It is now neutral in the long-term.

On a week-over-week basis, VIX call prices have risen very modestly and VIX put prices have fallen very modestly. At +165 versus +150 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is modestly higher and at this level it is now moderately bearish in the very near-term. It remains neutral in the long-term for now. Keep in mind, this is not only a contrarian indicator, it tends to be one of the earliest indicators I discuss in this report, and it can also change directions very quickly.

VIX Futures

At the moment, the difference between the sum of the 3rd and 4th month futures and the 1st and 2nd month futures is +3.08 versus +1.72 last week. This increase is mostly due to falling near-term expirations, while the later expirations have not moved much this week.

As of this writing (mid-day Friday 9/13), the nearest VIX futures contract (which expires on 9/18) was trading at 14.55, ¾ of a point above the spot VIX level of 13.80. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 14.31; about a half point above the spot price.

With an adjusted level that is about a half point above the spot price, futures traders are indicating that they believe the VIX is likely to tick up modestly in the near-term. Therefore I see VIX futures as moderately bearish in the near-term for the market. The RPAPs of the next two closest monthly futures contracts are 15.44 and 15.09 respectively. With the RPAPs of the further-dated contracts both more than a point above the spot price, I see VIX futures as moderately bearish in the long-term for the SPX.

Since VIX futures are typically much less reactive to current market conditions than the VIX index, near-term for VIX futures usually means a few days, while long-term means a couple of weeks.

The VIX has calmed down a lot this week, and the VIX Hedging Effectiveness is now back to Poor in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing very little sensitivity to market volatility, and are unlikely to be effective as hedging tools in the very near-term. VIX Hedging Effectiveness is Good in the long-term.

VIX Hedging Effectiveness is a manner of measuring the magnitude of VIX moves relative to the magnitude of SPX moves in the opposite direction. When the VIX is highly reactive, VIX related products can serve as potentially effective hedging tools, when the VIX is not very reactive, traditional hedging techniques may be a better choice.

Global Review/Outlook:

North America

On Tuesday (9/10) President Trump terminated his third National Security Advisor John Bolton, or he resigned, depending upon which of the two you ask. Normally this wouldn’t be surprising news, but it caused about a 7% drop in crude oil prices. Apparently while President Trump had expressed interest in meeting with Iranian leaders and potentially easing economic sanctions, Bolton was opposed to that idea. Easing sanctions on Iran could lead to Iranian oil re-entering the global crude market, and such a supply increase would likely mean lower prices. European allies no doubt see this as a positive development as they have been pressured by the U.S. not to buy oil from Iran.

Separately, on Thursday (9/12) President Trump gave equity markets a boost when he announced that he would postpone a previously scheduled tariff increase on about $250B in Chinese imports, from October 1st until October 15th. While market optimism has risen this week, Treasury Secretary, Steven Mnuchin dismissed speculation that the administration is working towards a watered-down deal ahead of the 2020 presidential election, saying that President Trump, intends to keep existing tariffs in place and is even prepared to raise tariffs if needed.

Asia

On Thursday (9/11) Chinese trade officials announced a list of $1.6B of U.S. imports, on which new 25% tariffs would be exempted, leading to more speculation that China is suffering from the trade war, worse than the U.S. The exemption will take effect on Tuesday (9/17) and include such products as pharmaceuticals, lubricating oil, alfalfa, fish meal, and pesticides. Tariffs on these products began back in July, and these moves are in response to exemption requests that have been approved in the interim. Further exemptions are also expected after the next round of exemption requests closes on October 15. For now, Chinese trade officials are still planning to travel to Washington DC next month for another round of trade talks, which they are hoping will focus only on trade matters and avoid the issues of Hong Kong, national security and human rights.

Separately, Hong Kong Chief Executive, Carrie Lam said that she could not endorse calls for the U.S. to pass a law allowing for annual assessments of Hong Kong’s special trading status, despite calls for such action by protestors outside the U.S. consulate in Hong Kong.

Europe

This week in Brexit news, U.K. Prime Minister, Boris Johnson published a paper that described the likely “worse-case-scenario” Brexit outlook. The paper predicted the potential for food and fuel shortages, supply chain disruptions, and public protests. It also anticipates widespread delays in the transportation of freight between the U.K. and France, a lack of availability of medications, fresh produce, seafood, and fuel, as well as disruptions in financial services, and road traffic. Perhaps most interesting is that it seems contrary to Mr. Johnson’s own perspective that the U.K. would be fine in the event of a no-deal Brexit. You’ll recall that last week Parliament passed a law preventing such an outcome, and forcing Mr. Johnson to go back to the bargaining table with the E.U., whether he wants to or not. It remains to be seen if he will comply.

Economic reports for next week:

Mon 9/16

None

Tue 9/17

Industrial Production & Capacity Utilization for Aug – Industrial production measures industrial output as a percentage, relative to output from 2007. Capacity Utilization measures output potential as a percentage, relative to the actual output from 2007.

Wed 9/18

Housing Starts and Building Permits for Aug – Housing starts measure the beginning of the excavation of the land on which a new single or multi-family residence will be built, and is used as a gauge of housing demand and strength in the construction industry. Building permits are required before excavation can begin, and any changes in permits are often reflected in starts in subsequent months.

FOMC Rate Decision – Fed Funds Futures indicate a 98% chance of a rate cut; 98% chance that it will be 25bps, and nearly 2% chance that there will be no cut at all.

Thu 9/19

Initial Jobless Claims - For the week ending 9/7/19, claims were down 15k to 204k after being up 3k the prior week. The 4-week moving average now stands at 213k, down 4k from the prior week. With this change, the 4-week moving average is now 11k above the 48-year low set on 4/13/19.

Existing Home Sales for Aug – This is a good measure of overall demand in the housing market, because it aggregates completed closings on all single family dwellings, which comprise the largest portion of the housing market. Home buying can imply economic stability, since it is often the largest single investment for any family. It can also lead trends in future durable goods purchases.

Leading Economic Indicators for Aug – As you probably know, this is more of a trailing than a leading report since the 10 components have already been released. As a result, the market reaction is usually fairly muted.

Fri 9/20

None

Interest Rates:

While the Fed was in a quiet period this week ahead of the 9/18 meeting, President Trump was not. On Wednesday (9/11) President Trump attacked the Fed on Twitter, calling them “Boneheads” and saying that interest rates should be at zero or less.

While the Fed will not be cutting rates to zero next week, it will almost certainly be cutting rates. The Fed Funds Futures probability of a 50 bps rate cut on Wednesday (9/18) has fallen all the way to 0% (yellow box) from about 13% last week. Perhaps even more interesting, there is a 98% chance of a cut (green box) and for the first time in many months, there is more than a 1% chance (red box) that there will be no rate cut at all.

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

The economic calendar is fairly light next week but all eyes will be on the Fed and its post-FOMC meeting press conference on Wednesday (9/18). A 25 bps rate cut seems a virtual certainty and since that is already baked into the market, “buy the rumor; sell the news” is a very distinct possibility.

Bottom Line:

China has agreed to come to Washington for more trade talks next month and both sides have softened a bit on the tariff front. Economic data is improving, inflation and long-term interest rates continue to move higher, and the SPX seems almost certain to reach a new high soon. But further rate cuts after 9/18 are looking less and less likely, and with the SPX +5.7% in the past 3 weeks, sentiment seems extremely stretched to the upside. Negative seasonal factors often come into play this time of year too. In other words, while the markets are acting like there is nothing to worry about; there is plenty to worry about.

As you can see below, there were more upgrades than downgrades in the indicators this week, and while volatility has fallen even further, the consensus outlook for next week remains Moderately Bearish. However, regardless of what the data shows, this caveat shall remain until further notice, “Trump’s tweets still trump everything else”.

Past performance is no guarantee of future results.

Key:

OI = Open Interest

OIPCR = Open Interest Put/Call Ratio

VPCR = Volume Put/Call Ratio

IV = Implied Volatility

+ means this indicator has changed in a bullish direction from the prior posting.

– means this indicator has changed in a bearish direction from the prior posting.

+/ – means this indicator has changed bi-directionally; i.e. last week was either Volatile, N/A or Breakout.

What You Can Do Next

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